This paper examines Zambia's Request for a Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF). Through end-March, most of the key quantitative benchmarks and six of the eight structural benchmarks under the Staff-Monitored Program (SMP) were observed. The PRGF-supported program is based on a strong fiscal adjustment envisaged in the 2004 budget and a modest growth of reserve money. A sharp decline in domestic financing of the budget relies on expenditure restraint. Despite the adjustment, the government targets a significant increase in poverty-reducing spending.

1. At the time of the Article IV consultation discussion last April, the Board had the opportunity to appreciate the continued improvement in Zambia’s economic performance and also the authorities’ resolve to continue to strengthen macroeconomic stability and step up structural reforms, to sustain higher economic growth and to reduce the prevailing high poverty. Important steps in this regard, were the undertaking of determined efforts to address the weaknesses in policy implementation faced in the recent past and marshalling wider political support to buttress the ownership of the reform program. This is reflected in the satisfactory manner in which the Staff Monitored Program (SMP) was implemented as manifested by the observance, some of them by large margins, of most of the performance criteria and structural benchmarks through April-2004, as well as in complying with the prior actions for the new PRGF program.

2. During 2003, the economy continued to expand at positive rates and inflation has been brought down to 17 percent, the lowest level in over two decades. Notwithstanding these favorable outcomes, my authorities are firmly committed to persevere with prudent policies, essential for addressing the economy’s remaining vulnerabilities. Hence, they have embarked on an ambitious reform agenda to be implemented in the context of a medium-term adjustment strategy for the period 2004–07, aimed mainly at further enhancing the efficiency of government operations, promoting an enabling environment for private sector development and strengthening governance. In line with the objectives established in the PRSP, this strategy will remain focused on accelerating economic growth through improvements in total factor productivity and most importantly, by means of further diversification efforts that could result in new employment opportunities and reduction in poverty.

3. The government’s medium-term reform strategy envisages the attainment of a real GDP growth of at least 5 percent per annum, the reduction of the inflation rate to single digits by the terminal year of the program period, and the strengthening of the international reserves position. In pursuit of these goals, the strategy will maintain its focus on three main pillars: (1) diversification of the sources of growth; (2) strengthening of fiscal position; and (3) supporting private sector development. The government is also committed to improve governance and transparency, to promote an enabling investment climate.

4. Despite the encouraging growth performance during the past several years, the authorities recognize that the projected annual growth rate of 5 percent over the medium-term is not enough to meet the Millennium Development Goals (MDGs) targets. They are therefore, by improving the provision of basic services and establishing an investment climate that is conducive for greater private sector participation, expecting to move the economy towards a higher growth path, The authorities are confident that the launching of the Private Sector Development Initiative (PSDI) that is being prepared through a process of consultation with key stakeholders, will contribute to improve the environment for private sector growth and accelerate domestic and foreign investment. Moreover, since the majority of the poor population is concentrated in the rural areas, priority attention will be accorded to supporting agricultural development and the expansion of basic infrastructures to facilitate growth. This has not been given adequate attention in the previous programs as documented in the ex-post assessment paper, discussed last April.

5. My Zambian authorities look forward to the Board’s favorable consideration of their request for new three-year PRGF arrangement, which will be not only provide direct financial assistance in the implementation of Zambia’s medium-term reform strategy but also lend additional credence to the authorities’ program that could trigger support from the donor community.

Fiscal Policy

6. Since fiscal consolidation remains central to the government’s medium-term reform strategy, the Zambian authorities have reaffirmed their commitment to correct the fiscal slippages which occurred last year, by the bold steps they have taken during the implementation of the SMP in the first half of 2004. The fact that the fiscal adjustment effort will be front-loaded, while allowing for increase in poverty-related spending, is a further demonstration of their determination to preserve and consolidate these gains. This decision was undertaken in the belief that it would be necessary to break the cycle of rising domestic debt and interest payments that have beset their fiscal performance recently, thus contributing to preserving macroeconomic stability. As a result of this approach, the overall fiscal deficit is expected to decline substantially from 6.6 percent of GDP in 2003 to 3.4 percent in the current year, with further reductions envisaged beyond 2004. Although revenue is expected to increase by 0.6 percentage points of GDP in 2004, mainly as a result of the broadening of the tax base, the fiscal adjustment will rely essentially on expenditure containment. In particular, it is anticipated that the wage bill will be strictly restricted to less than 8 percent of GDP and there will be no general wage increase in 2004. Significant savings are also expected to occur from the ongoing re-organization of operations, substantive cuts in discretionary spending, especially under recurrent departmental charges, and particularly, from the rigorous enforcement of the commitment control system (CCS) that will improve the budget execution system. The authorities remain firm on their commitment to avoid unbudgeted spending.

7. In addition to these measures, the authorities believe that a comprehensive reform of the public sector is required to produce a lasting effect on the improvement of the efficiency of government operations. To this end, they intend to commence the implementation of the Public Expenditure Management and Financial Accountability (PEMFA) program in 2004, for a more effective management of public resources and enhanced accountability. The authorities are also in the process of developing a plan, with the assistance of the World Bank, to streamline the civil service and restructure the pay system. These measures will enable increased spending on priority poverty-reducing programs to facilitate progress towards achieving the MDGs targets. The government reaffirms its policy of zero tolerance for corruption. As part of the effort underway to improve transparency, the government will be publishing the quarterly reports of budget execution and is taking steps for enhancing the independence of the Office of the Auditor General.

Monetary and Exchange Rate Policies

8. The authorities will maintain prudent monetary and exchange rate policies to achieve the projected program targets for inflation and international reserves. The planned reduction in fiscal reliance on bank borrowing will provide room for a significant increase in credit to the economy. The authorities recognize that interest rates on Government securities declined rapidly as a result of the reduction in reserve requirements in October 2003. They reiterate that the easing of the monetary policy was well received by the business community and, most importantly, has achieved the intended objective of increasing credit to the private sector. They are, however, aware of the potential risks that a rapid decline in interest rates may pose to other macroeconomic variables, such as inflation and exchange rate. Therefore, the central bank will continue to monitor closely monetary developments and take necessary actions to ensure that credit and broad money are kept within the limits envisaged in the program. Consistent with this, and taking into account the domestic financing requirements, adjustments are being made to the tender sizes for government securities, effective June 7, 2004. The exchange rate will continue to reflect market conditions with the central bank limiting its intervention in the market only to smooth out short-term fluctuations.

9. The authorities are also moving forward in taking the necessary measures for addressing the weaknesses identified in the Financial Sector Assessment Program. In this regard, they are in the process of finalizing the Financial Sector Development Plan (FSDP), which seeks to deal with these problems, in particular, the need to accord greater autonomy in the formulation of monetary policy, the strengthening of the authority of the central bank, and resolving the problem of insolvent state-owned nonbank financial institutions (NBFIs). The authorities also view the development of the regulatory framework for microfinance institutions as an urgent step to support the small and medium-scale projects, which have a critical role to play in promoting growth and creating job opportunities.

External Sector

10. Zambia’s external current account position is projected to improve somewhat on account of higher copper prices and increase in nontraditional exports. The country’s trade regime remains open and supportive of export development and economic diversification.

11. A major problem for the authorities has, however, been the large external debt overhang, which they view as a serious impediment to boosting investment and growth and to reducing poverty. In this regard, they made significant progress in meeting most of the triggers for the HIPC completion point. They are, however, not only greatly disappointed but also highly concerned with the delay for the consideration of their HIPC completion point, brought about by the proposed postponement to early 2005, based on the need for a minimum of six months track record of good performance under the PRGF arrangement. They request that since the strength of the reform measures implemented under the SMP since January 2004 is the same as of those described under the PRGF arrangement, this should be taken into account in the evaluation of the country’s track record of sound economic management. A period of assessment from January to, say, October 2004 should provide adequate extended period for evaluation to enable Zambia to attain the completion point by December 2004, as initially envisaged. Even maintaining the start date for the PRGF arrangement on May 1, 2004 as initially agreed with the authorities, would still enable Zambia to reach the completion point by end-2004, provided that the six-months track record to October 2004, remains satisfactory. The authorities are therefore, strongly appealing to the Board to consider favorably their request to maintain the start date for the program on May 1, 2004.

12. For the authorities, any delay beyond December 2004, would carry the great risk of jeopardizing the credibility of the government and more importantly eroding public support for the reform program. Another serious consequence of such a postponement would be to prevent the allocation to poverty-related spending, of the additional resources that would accrue from the HIPC debt relief, thus making it even more difficult to meet the MDGs, than is the case presently.

Conclusion

13. Lastly, I would like to convey my Zambian authorities’ gratitude for the Fund’s continued support, in helping the country face its many complex challenges.